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Working Paper
The Causal Effect of Debt on Interest Rates
This paper uses a natural experiment to measure the causal effect of an expected debt-financed fiscal stimulus on interest rates. We find that a 1 percentage point increase in the expected US debt-to-GDP ratio leads to an increase of about 1-2 basis points in the longer-run neutral rate (r∗) and of about 2–3 basis points in the 10-year Treasury term premium. Our results validate estimates from a common time-series approach that regresses long-term forward interest rates on long-term projections of government debt, where the exclusion restriction does not apply.